Condo audits uncover four common issues

Professional advice may be in order when corporations confront ambiguities

Tuesday, February 14, 2017

By John AbedRabbo

With few exceptions, the Condominium Act of Ontario (the act) requires an independent auditor to perform an annual audit of the financial statements of a condominium corporation. Sections 60 and 71 underline the rights and responsibilities of an independent auditor.

It’s important for unit owners to understand that an independent auditor does not prepare the financial statements, nor is he or she responsible for the daily bookkeeping and management activities. These activities are the responsibility of management and the board. The auditor’s responsibility is to provide an independent opinion as to whether the financial statements are fairly stated in accordance with the applicable accounting standards (in Ontario, these would be the Canadian accounting standards for not-for-profit organizations).

However, during an audit, an auditor may come across certain issues related to financial or operational matters that may need to be highlighted to management and the board, and in some circumstances to unit owners as well. These issues are not misrepresentations nor errors that would cause the financial statements to be false or misleading. In fact, if the statements have material errors then the auditor may have to qualify his or her report, or even worse, issue an adverse audit opinion.

This article addresses some issues that don’t necessarily cause the financial statements to be false or misleading, but quite frequently come up during an audit and would typically be brought to management, the board and unit owners’ attention.

1. Reserve fund-qualifying expenses

Section 93(2) of the act states that the reserve fund shall be used solely for the purpose of major repairs of the corporation’s common elements and assets if the corporation has the obligation to repair or replace these items. Quite often there is some ambiguity about what constitutes a replacement. Would replacing carpet flooring with ceramic flooring qualify as a replacement? Would replacing certain equipment with technologically more advanced equipment qualify? There is no simple answer here and every situation should be evaluated individually. Obviously, when evaluating each situation, one must consider the reserve fund study, technological advances, statutory requirements and the incremental cost.

Another issue that comes up frequently is whether the corporation has an obligation to repair or replace an item. One recent example that hit the news is the Kitec plumbing issue. The Toronto Star reported on this topic a year ago, stating that one condominium corporation anticipated a retrofit cost of $5,000 to $6,500 per unit. Further, the article stated that owners must pay for this retrofit directly (i.e. those expenses cannot be charged to the reserve fund). The management and board should consult with professionals, such as engineers, lawyers and auditors, before making a decision in case of an ambiguity.

2. Reserve fund study delays

This is somewhat a simple issue but commonly occurs. The act states that a reserve fund study must be conducted within three years of the preceding study. Auditors frequently find that the corporation has simply not commissioned a new study within the prescribed period. There should be no reason to delay the study past the three years. This should be considered as important as a person’s annual check-up at the doctor, except the corporation only has to do its financial check-up every three years.

3. Borrowing money “unintentionally”

This issue frequently catches boards and management by surprise and usually after the fact. Essentially, a condominium corporation may not borrow money unless it passes a special bylaw (with support from a majority of unit owners) to authorize borrowing. Boards and management may get caught in situations where the supplier provides long-term financing, which may be considered borrowing if it meets certain criteria, such as implied or explicit interest on the financing.

Thus, the board and management should always check the specifics of the financing arrangements and consult with an accountant before signing these contracts. If a borrowing bylaw is required, consult legal counsel as well.

4. Bank and investment accounts

Every condominium corporation in the province must maintain at least two bank accounts with an eligible financial institution in Ontario. One account should be used for the operating activities and the other for the reserve fund activities. Further, these two accounts must be under the corporation’s own name and must be designated as operating and reserve fund bank accounts. Thus, not meeting any of the above mentioned guidelines would be an issue that the auditor would typically highlight. Obviously, the solution is to follow these guidelines.

The one issue that auditors frequently encounter, however, is the comingling of cash. Or, more specifically, the corporation is using cash in the reserve fund bank account to finance operating activities. This commonly happens when a corporation has a large operating deficit and so uses its reserve fund assets to finance its deficit. The solution to this issue is proper cash flow management and budgeting, which includes deficit recovery budgeting.

As for investments, the act specifies what a condominium corporation may invest in — what are defined as “eligible investments.” For obvious reasons, the act allows low-risk investments, such as guaranteed investment certificates, term deposits and some bonds.

The act also requires that the corporation establish an investment plan for the reserve investments. This is essential to ensure liquidity and to safeguard the assets. Frequently, auditors find that condominium corporations don’t have a formal investment plan. This is a simple process and should be based on the reserve fund study.

To avoid these common audit issues, the board should retain the services of a reputable management company that understands the industry and the act, and is willing to work with other professionals. Upfront consultation is always cheaper than settling the legal issues that may result from not following the act.

John AbedRabbo, CPA, CA, CPA (Illinois) is a chartered public accountant and has more than 15 years of experience in accounting, audit and tax services. John is a partner at Polyzotis & Co. LLP, Chartered Accountants, a Toronto-based firm. John’s practice is focused on providing audit services to more than 90 condominium corporations. He can be reached at 416-360-4310, ext. 240 or by e-mail at: [email protected]

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